As Prime Minister, Kevin Rudd has made his share of bad calls on climate change policy: he wasted the bipartisan consensus for an emissions trading scheme in 2009, then shied away from a double dissolution election. Now he seeks to make his government a smaller target on climate change by trying to seem like he is dismantling Labor's own legislation.

The government's plan to link Australia's carbon price to the European emissions trading scheme a year earlier may look like good politics because it produced the headline "Rudd scraps the carbon tax". But it is not good policy.

The European carbon price is depressed by the miserable outlook for economic growth across much of Europe. Together with huge subsidies for renewables, energy efficiency standards and other policies, it means that there is little left to do for the emissions trading scheme in meeting the EU emissions target.

So the price in the EU scheme is low, only about $6 a tonne - less than half the price in the Californian trading scheme, and about a quarter of the Australian fixed price. The European trading price is much lower than the actual cost of climate change effort in Europe, and it is far below what a carbon price would be under effective global climate action.

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The European price could of course rise in future. Some forecasts predict sharply rising prices, on various assumptions. But futures markets, where companies invest their money according to their expectations, have 2020 EU permit futures at only about $8.

The EU price could even fall. It depends on Europe's growth outlook and changes to its carbon policy, both uncertain. In Australian dollar terms, the exchange rate matters also.

Australia's economic situation and outlook is very different from Europe's. Under a carbon price at current European levels we would meet our emissions targets mostly by buying international emissions units, including European permits.

There is nothing wrong in principle with international emissions trading, indeed it could be an important part of internationally harmonised climate action in the future. But if the price is low, then it will not drive the shift to a lower carbon economy in Australia. We would need to rely on regulatory measures or subsidies for that, and they are typically costly and messy.

Then there is the budget. The government has identified savings to offset the expected shortfall of almost $4 billion in 2014-15, with sensible measures such as the reduction in free permits to power stations and reforms of fringe benefits tax for car use.

Nevertheless, every dollar that businesses and households pay less for carbon is a dollar missing in the budget. Lowering the carbon price means government needs to raise more revenue from other taxes. The bottom line is that a government committed to the carbon price should make sure the price level does not drop too low.

If it wasn't for the poisonous politics of the "carbon tax", the best option would be to stick with the gradually increasing fixed price, and keep it for longer. The effect on cost of living from the $23 carbon price has been minor, and most households are better off financially because of income tax cuts and welfare increases.

Impacts on industrial competitiveness have been negligible. Keeping the fixed price would cause no further impacts. The carbon price immediately reduced emissions from the power system, because it made some of the dirtiest electricity plants too expensive to operate. Lowering the price could undo many of the gains, bringing old clunkers online once again.

None of this would be a problem if the government had retained the price floor that was originally legislated. It would have provided a safeguard against excessively low prices under international permit trading, and provided more investment certainty. The price floor was dumped when independent MP Rob Oakeshott withdrew his support. Industries lobbied against the price floor on grounds of implementation difficulties, but international examples show it can be done. Britain has a price floor for its power industry, currently at $26 and rising. California also has a price floor, at a level below the current trading price.

There is one other little-discussed option: to float the Australian carbon price, but only as a domestic market, not linked to the EU scheme. The price would vary according to Australia's economic and policy developments. EU permits could be allowed into Australia, but with a tight limit so they do not determine the domestic price.

The domestic market option would be consistent with Rudd's anti-tax stance yet provide stronger incentives for low-carbon investment in Australia. But it would no doubt trigger a ceaseless lobbying effort by industry, precisely because it would mean a higher price.

And so we will probably get legislation to link to the EU market in mid-2014. The change is relatively minor, but is one more instance of moving the goal posts mid-game. Then again, the policy uncertainty created by the opposition's position is much greater still. Investors are clamouring for stable settings for climate policy, and they are still not getting them after all these years. Australia's climate policy remains in a difficult spot.

Frank Jotzo directs the Centre for Climate Economics and Policy at the ANU Crawford School of Public Policy. He is a visiting researcher at the Centre for European Economic Research in Germany.

159 comments

Do I understand this correctly? If I buy a carbon permit from Europe, I get a piece of paper in effect. In the meantime, someone in Europe gets a new facility of some kind. I've also read that we're likely to spend billions buying these pieces of paper.

Commenter

jhsp

Date and time

July 19, 2013, 6:37AM

Hi folks! This ETS change will save you 360$ a year anually. Whats the problem? We're changing the weather! Hahaha- Thank me!

Gotta zip!

Commenter

Kevin

Date and time

July 19, 2013, 8:42AM

"Hi folks! This ETS change will save you 360$ a year anually. Whats the problem? We're changing the weather! Hahaha- Thank me!"

Actually it is $360 only, not $360 annually mate

Commenter

Carstendog

Location

Here

Date and time

July 19, 2013, 8:56AM

I think that was the intended satire^^

Commenter

Alex

Date and time

July 19, 2013, 9:08AM

"Do I understand this correctly?"

Thats the thing - you don't. Not even close. But why should you, its really complicated and I'm sure you're not an expect.

If a doctor told you that you had MS - would you really expect to understand in detail what the disease was about, what the treatments were doing? Why would you expect to understand something that takes experts years of experience to really understand?

Commenter

M

Date and time

July 19, 2013, 9:14AM

This scheme was designed and is run by the same clowns who have managed european economies over the last 10 yeras. The EU met recently and decided to take a huge number of carbon credits off the market o try and drive up the price. Rudd has made his bold predictions based on $6 a tonne. What if its $12 or $18 ? What happens then. Will lefties still be cheering?

Commenter

Denny

Date and time

July 19, 2013, 9:23AM

This is how it is supposed to work (very simplistic & briefly): An individual does not buy a permit.

A business (that emits say, 200 tonnes of carbon) buys a permit (off any business in the world) to emit a certain amount of carbon at the going price eg their permit is to produce 100 tonnes of carbon only and it costs them $600. They have to change their production processes (technology investment) in order to bring down their emissions to 100 tonnes. Once they do this they can then sell their permit for 100 tonnes to another business at the going rate. If it's higher than when they bought it they make a profit or they could make a loss, just like shares.

So, its an economic incentive for a business to reduce carbon at no taxpayer expense, and they could make hefty profits. Production processes usually become more efficient so with profit and efficiency, prices of goods and services actually come down. In time say, electricity prices could be very low. The only problem with it, the technology to improve production processes has to be available at the right price, but compensation for households needs to be in place in this interim period.

The likelihood of higher profit, higher share dividends and share values for a business ALWAYS OUTWEIGHS taxpayer subsidies given to it to reduce carbon. We live in a world of economic incentives, not handouts. An ETS is a better solution than a taxpayer handout.

Commenter

JT

Date and time

July 19, 2013, 9:28AM

I agree with what Frank wrote... except for the bit where Rudd by making this 'concession' stands a much better chance against Abbott so we avoid the disaster of Abbott's austerity and business 'prioritised' econonics. Rudd should look to move to a domestic model after he wins the election. Or Turnbull will get in and he can do the right thing.

Sometimes you need to see the big picture.

Commenter

QED

Date and time

July 19, 2013, 10:03AM

And soon you'll be paying $350 per tonne for that piece of paper which will syphon money from Australia and into overseas pockets. This while our emissions are reduced by ZERO! Another great policy from the party of great policies - with Labor at the helm, who needs enemies? They've proven themselves over and again to be very capable of killing of our jobs and our wealth. And now Rudd is continuing this great Labor tradition.....

Commenter

len

Date and time

July 19, 2013, 10:06AM

If a business buys a permit for $50 per tonne but they sell it for $350 per tonne 5 years later.......is that a profit len? What has this got to do with taxpayers money??????? Its a PROFIT to be used to share with shareholders........business can make big bucks out of an ETS.......that's why they are not winging about it.